   |
|||
Dollar Dive Due Any DayRalph Kettell The U.S Dollar Index has been balancing on the edge of a razor for some weeks now. It can't decide whether to rise or fall and at the moment is trading in no mans land. Will it move up and break out of the long term downtrend which has been in place since February of 2002 or will the downtrend resume? Some have argued that once interest rates start to rise, the dollar is certainly going to rally. After all when interest rates rise, the dollar has to go up, doesn't it? In normal times, the usual relationship between the dollar and interest rates would hold up, but folks these are far from normal times. What can U.S. investors believe or for that matter what can ordinary U.S. citizens believe? Can they believe the government statisticians? Can they believe Alan Greenspan? How about Ben Bernanke, can they believe him? Naaaaaaaaaaah, of course not, none of the above, nada, zero, zilch! In the past, Greenspan and company would telegraph what they were going to do and let the markets respond accordingly. Then they would usually (perhaps only after the jawboning stopped having the desired effect) follow through what they had earlier hinted at. Now Greenspan, Bernanke and company tell the markets what they are proposing to do, they watch the markets respond, and then they say, "Oh we changed our minds, we didn't mean what you thought we said. Mr. Market you misunderstood us!" A case in point is the bond bubble of last year. Greenspan and his boys told the market that they would support lower rates all along the yield curve, even to the point of dumping dollars out of a helicopter or buying long dated treasuries. 'Sir' Alan sent his new spokesperson, Ben Bernanke, to the microphone to proclaim, " but the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost." This helped propel the bond market to new heights. Then in June of 2003, Greenspan stood up and said, "just kidding, we're not going to buy long dated bonds, and well now we don't think that deflation is really going to be a problem, sorry about that". As a result, the bond market tanked while long bond rates and mortgage rates said goodbye to the lowest levels in 50 years. What is 'Sir' Alan up to now? He has several major problems at the moment. The equities market needs a constant nudge to keep it from falling, and rates need to stay as low as possible to keep the economy moving forward. Mr. Greenspan would love keep mortgage rates low, but he also senses the need to at least make a show of fighting the inflation that they won't admit to. Ostensibly, the move to raise interest rates is grounded in the fact that the economy is now growing so strongly that rates must rise to prevent it from overheating and thus from inflation becoming a problem. I don't think he has to worry about the strength of the economy, because I believe that most of the numbers which have been supporting the premise of a healthy economy have been fabricated by the statisticians. Why would anyone do that? Perhaps it has something to do with the U.S. being in the middle of a presidential election year? Greenspan of course is privy to this information while we are only guessing. As for inflation, I don't think they should worry about it becoming a problem. What they should do is be scared to death as to how the heck they are going to solve the terrible inflation problem that we already have. That would be the same inflation problem that they single-handedly created with their incredibly-easy-money policy. Of course that is another statistic which is held in check by the creative boys (and girls) over at the U.S. Bureau of Labor Statistics. How can I scoff this way at the inflation numbers? Well a few days ago, I had to buy gasoline for the car at $2.23 a gallon while I was on the way to the grocery store to grab a couple items for my lovely wife. I bought a pint of light cream and a pint of whipping cream. I couldn't believe the price of either. The pint of light cream was $1.99 and the heavy cream $3.49. Wow! A few months ago I could buy a quart of the light cream for $1.99 at the same store. I braced myself as I glanced down to see what a gallon of milk was selling for and was astounded yet again with a price of $3.75. Approximately a year ago, the same gallon of milk went for $2.20. The cows must be holding back on the farmers. Certainly the increase in the cost of gasoline used to transport the milk can't account for all of that tremendous increase! Please excuse my unscientific digression above, I should know better. The metrics which I listed are all part of the now infamous volatile food and energy sector (VFAES), and therefore not part of the core CPI number. Why are they volatile? Simple, because people need them and therefore they buy them, irrespective of the cost. Therefore, the demand for food is relatively constant. People need to eat to continue living. If food prices rise, guess what? People still buy about the same amount of food. In economic terms, this means that the demand for food is highly inelastic. As the prices for food rise or fall, the amount of food purchased, doesn't vary much. The demand for the core goods in the CPI, however, is highly elastic. In simple terms, demand is elastic when quantity of goods purchased is indirectly related to the price and is very price sensitive. This means that as the price rises, people quickly scale back their purchases, or conversely they buy a lot more when prices fall. For example, if the price of cars go up significantly, less folks buy new cars and instead they repair their current vehicles. Conversely if the dealers give big rebates and finance the cars at zero interest rates, the cars race off the showroom floors. Gee when have we seen this happen? The end result of the price elasticity or inelasticity is that if consumer's incomes are not growing as fast as the cost of living, they will reapportion their spending. They will not buy less food, as we discussed above, but they will buy fewer cars, boats, houses, etc. Thus the price of food tends to stay high while the prices of items less necessary for survival get hammered by a major shift in the demand curve for those items. The net result is that the government gets double duty by removing the volatile food and energy sector (VFAES) from the statistics. First, they reduce the inflation numbers by ignoring the items which are rising faster and farther. The secondary effect, however, is the non-essential (or less essential) items which the government chooses to include in the CPI, do not rise as fast as they might. This suppression of the rise in the prices of non-essential goods is due to less dollars chasing after them resulting from the reapportionment of consumer spending to essential (aka VFAES) goods. Before my digression into the modus operandi of the Fed and the distortion of CPI reporting by the Bureau of labor statistics, I asked the question, "What or who can we believe?" The Fed has been jawboning about a rate increase for some time now. Well they followed through with their threat to raise rates last week with a big 1/4 point increase. In one sense it could be interpreted as a large increase in that it was a 25% increase from 1% to 1.25%. However, if one considers that interest rates were way out of whack by being so low, then a 1/4 point rise is as if to say "So what?" The rates are still at historically low levels: lower say than 98% of the time in the past 50 years (with the past year being the notable exception). Let us attempt to delve into the inner sanctum of 'Sir' Alan's brain to ferret out the intrigue he has planned which necessitated him to talk up interest rates. I believe that Mr. Greenspan knows the dollar needs to fall to help balance the humungous, out of control, never before seen or conceived of trade deficit of approximately $600B per year at the current rate. However, he knows that allowing the dollar to fall will encourage investors to buy gold especially in light of the budding inflation pressures. He is trying to balance the need to maintain over valued equity prices, help President Bush get re-elected, keep a lid on gold price excitement, and posture about not allowing inflation to resurface. Mr. Greenspan and company have just begun to raise rates, but they are highly unlikely to do so in a meaningful way until after the election. Even after the election, the rates are unlikely to rise very fast because of the weak state of the US economy. I firmly believe that the interest rates will not rise significantly until one or both of the following events occur: 1) the dollar drops too far and too fast for comfort and/or 2) the inflation rate takes off. 'Sir' Alan, the Fed, and the Bureau of Labor Statistics will do their level best to hide these facts from the public, but at some point they will fail. When that occurs, interest rates will rise in spite of the economy being lethargic. In the past few weeks, several prominent members of the Fed have come out and said that they don't believe this or that tendency or statistic present in the economy will translate into drastically increased inflation. Of course it won't, they're going to lie about it. You better believe if they are trotting out "experts" claiming that inflation is not going to be a problem it darn well is a problem already and they are terrified by the prospect. Since they are scared to death, they are turning up the volume on their propaganda campaign. What does this all mean for the future direction of the dollar? If interest rates were really going to rise meaningfully relative to the inflation threat, then it would likely mean the dollar would rise. However, if this is just a "window dressing" rate increase(s) (as I suspect) then the dollar is not likely to rise, it will rather continue its downtrend. I believe that timing is everything, and we are at a crucial juncture in the U.S. The first and foremost concerns of the FED are not allowing stocks to fall and getting the President re-elected. This means talking up a rate increase, but keeping it quite small. We have now had and the market has digested the first 1/4 point rate increase. 'Sir' Alan will now allow the dollar to fall as the incredible liquidity flood continues. When the dollar decline gets out of hand and looks like a rout is starting, the rates will rise for real. When the inevitable rate increases start (after the election) and the dollar has established a new lower trading range around 75 to 78 on the US dollar index, then many new market dynamics will come into play. The stock markets will have corrected or perhaps crashed at that time in anticipation of the imminent pain to be inflicted by the rate increases. The dollar will steady while bond holders are running for the hills. Gold will have decoupled from the dollar and will be growing legs of its own. The gold bull will gain a life of its own and will not merely be a caboose on the dollar bear train. Gold will be in a true bull market in all currencies. The interest rate increases will not be driving gold lower, rather gold will be driving interest rates higher. That in a nutshell is what I see in my crystal ball for the short to intermediate term. Let's see what the charts have to tell us on the matter. On a short term basis the dollar has formed or is forming a head and shoulders topping pattern as shown on the 6 month dollar chart. The neckline is the 88 - 89 area which has been a congestion zone on the dollar chart for the past 8 months. When the right shoulder is completed in the next few days/weeks, the near term target is the intermediate double bottom at 85 from January and February. Also evident on the chart is the dollar's inability to breakthrough the 200 day moving average in the past month. It seemed quite strong for a while in May and traded above both the 50 day and 200 day moving averages. Now having broken down, it is rather weak. It has been repelled to the downside by the 200 day moving average multiple times, and the 50 day moving average is now turning down as well. In a few weeks, the short term 50 day MA will cross back over the longer term 200 day MA. By then, the direction of the dollar will be apparent to everyone.
From a fundamental viewpoint, the dollar has to fall. In spite of an approximately 30% drop in dollar in the past 2-1/2 years, the U.S. trade deficit has continued to climb. It is now at almost $600B on an annualized basis. There are only two ways for this situation to resolve. One is that the deficit continues to grow, which will require foreigners not only to continue their investment in U.S. assets at an unheard of pace but to increase the rate of their already gargantuan investment. How long will Japan deflate their currency by printing billions of Yen just to change them into dollars at a high USD valuation? I suspect that it will not continue for much longer. The three year chart of the dollar clearly displays that the long term down trend in the dollar is still intact. The dollar briefly poked its head out of the channel in early May and even slightly bounced above its 200 day moving average, but it was unable to hold its ground. It has now bowed out and is headed back down. The relative strength is headed down, the MACD is headed down, and the dollar will soon follow.
I usually don't do this, but I will go out on a limb and make a few specific predictions on the future value of the dollar. I will probably live to regret it, but here goes. I predict that the dollar will see 85 by late July or early August. Then by September or at the latest early October, the dollar will break down below 85, and before the year is out the dollar will see the 75 to 77 range. At that point the dollar will be oversold and another counter-trend rally will ensue. July 6, 2004
Disclaimer: |
Disclosure: